11/27/2012 01:41 pm ET Updated Nov 27, 2012

Too Big To Fail Banks Benefit Society, Says Too Big To Fail Bank

Wow, guys, you'll never guess who thinks too-big-to-fail banks are super great for society! OK, you'll guess: It's a too-big-to-fail bank.

In a research note published last week titled "Universal banks: Optimal for clients and financial stability," Deutsche Bank analyst Jan Schildbach makes the Panglossian argument that the mega-bank model pioneered by Citigroup in the 1990s is the best of all possible bank models.

"Universal banks are able to leverage revenue and cost synergies through economies of scale and scope," Schildbach argues. "These benefits are passed on to universal banks’ customers and investors. Ultimately these benefits lower the costs of finance for society as a whole."

It's just like Lloyd Blankfein's "God's work" comment, but with more words and slightly less inflammatory je ne sais quois.

Now, big banks say this kind of stuff all the time. But they don't always inspire must-read rants from bank analysts, such as the one on Tuesday by Christopher Whalen of Tangent Capital Partners at Barry Ritholtz's Big Picture blog.

"The TBTF banks are parasites that drain resources from society," Whalen reasons. "This ridiculous, self-serving analysis by one of the most hideous examples of 'too-big-to-fail' makes that point nicely."

Schildbach's paper doesn't directly address the issue of banks being too big to fail, but that's typically what you get when you let banks sprawl all over the globe with their tentacles in all sorts of businesses -- like, oh, say, Deutsche Bank. Or Citigroup, which in the 1990s egged on Congress to obliterate the Depression-era Glass-Steagall law separating investment banks from commercial banks and helped create the one-size-fits-all banks that lumber around the globe today. The prime mover behind that effort, former Citi CEO Sandy Weill, has since lost his religion and called for big bank breakups, but plenty of others have taken up his cause.

Many worry-warts worry that these banks have become something of a problem, too large and complicated to manage, particularly in the event of a crisis, and particularly now that they hog a bigger share of global banking than before the last crisis. You have got it all wrong, says Schildbach. These banks are a boon to society because of their size, not in spite of it.

Except Schildbach really doesn't address the hidden cost these same banks also impose on society. Here's how it works: The bond market knows full well that these banks are too big to fail and that the government will bail them out if they get into trouble. So they're perfectly willing to lend money to these banks at low rates. If we all thought these banks could fail like any other company, their borrowing costs would be higher than they are already, probably much higher. Let's say an extra $45 billion per year, as the Cleveland Fed recently estimated. Who covers that missing $45 billion? Society, to the tune of about $143 per American per year, estimates Dealbreaker's Matt Levine, using the Cleveland Fed's cost estimate.

You could argue, as Schildbach does, that we all benefit in some way from the lower borrowing costs of the banks. Except the banks aren't really passing their lower costs on to us so much.

And then, if and when the financial system goes kablooey, as happens occasionally, particularly when super-large banks borrow to the hilt at super-low interest rates, then society pays an additional tab, in the form of bailing out these banks. Schildbach and other big-bank defenders such as JPMorgan Chase CEO Jamie Dimon say their banks are more likely to survive crises by dint of their scale and scope. After all, it was the small, specialized banks, like Lehman Brothers and Bear Stearns, that got in the most trouble during the crisis. But that's not always the case.

"Of course, universal banks got into trouble as well: e.g. Citigroup in the US; RBS, Fortis and Dresdner Bank in Europe," Schildbach admits.

Of course. And let's not forget insurance giant American International Group, which also had a large, diversified business model and managed to get itself into a pickle in the crisis, requiring a large government bailout. Maybe most gigantic financial institutions won't fail in a crisis, but then they don't have to -- all it takes is a few very large ones, and you've got a big mess on your hands.

Meanwhile, though the bond market has no trouble lending to these banks, the stock market is less kind; most of these big banks trade at less than their book value. They're also sort of lousy at lending, according to a recent Keefe, Bruyette and Woods report, which is, you know, their traditional function. Come to think of it, they're not so good at investment banking, either.

"Overall, this DB report seems to be a feeble effort at public relations, not a true analysis of the financial and economic performance of the largest banks," writes Whalen in his blog post. "The only explanation that seems to make sense is that DB intended to publish this analysis as a PR piece, but somehow the wires were crossed and the report was instead published under the guise of serious research."



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